The Insolvency and Bankruptcy Code, 2016, (IBC) has opened up various possibilities for merger and acquisition (M&A) deals in India for companies eyeing inorganic growth opportunities. IBC proceedings provide corporate debtors with solutions against the liquidation process. Due to these reasons, it has opened new doors in M&A. As per the reports, till 2018, the M&A deals in distressed assets worth USD 14.3 billion were done in just 2 years of operations of the code. Indian economy is having surge in stressed assets and it is no wonder that the complexity of the problem has necessitated multiple changes to various laws and the introduction of several new ones.
The IBC endeavours to save the life of a company in distress. One of the most significant tools introduced to address the problem of stressed assets is IBC. In terms of actual deals, distressed M&As have accounted for about 3% of the total M&A volume in the Indian market and 21 out of a total of 623 deals completed since 2017. An M&A opportunity could also arise as a part of CIRP when, as part of the Resolution Plan, the Resolution Applicant has taken approval to divest all or parts of the corporate debtor’s assets through M&A activity over a pre-agreed period following the conclusion of the CIRP.
In the past couple of years, India has witnessed quick resolutions for tackling non-performing stressed assets and debts in India, including its restructuring thereof, by providing a powerful tool to the financial and operational creditors in the form of the Insolvency and Bankruptcy Code, 2016. When looking at distressed M&A in the context of IBC, the following are the key factors in the growth of distressed M&A activity-
Time Frame for Dealing with Stressed Assets :
One of the most sought-after aspects of the IBC mechanism is the time period allotted to agree on the terms and deal with distressed assets of an insolvent business. The IBC provides strict timelines for the completion of various stages of the process. The maximum time period for resolution is 9 months (including the grace period of 90 days). Although the process sometimes exceeds the above timelines, it’s still more effective than the court-driven process. This means the process and valuations of the distressed assets are carried out faster than when it is carried out by Merging/Acquiring entities while conducting personal due diligence on non-stressed assets.
Due Diligence under CIRP:
One of the most important exercises conducted during M&A is due diligence. It is undertaken by the merging/ acquiring entity to evaluate the target entity’s business, assets, future monetary potential, genuineness, and various significant factors to secure itself from future fiscal or litigation problems. It is paramount for the merging/acquiring investor to exercise due care and caution while conducting the evaluation. By undertaking diligence, the acquiring entity ensures visibility in order to determine the genuineness and legitimacy of the target entity, which would protect itself from future financial, commercial, and legal problems.
Further, the diligence process has a significant bearing on the outcome of the M&A transaction, in terms of the final commercials, appropriate reps and warranties to be obtained, negotiation leverage, and investment decision. Often times even after rigorous due diligence has been conducted, litigation and financial issues still fall through the cracks, which makes the M&A transaction unfavourable and troublesome for investors. IBC with the initiation of the CIRP, suspends the Board of Directors of the distressed business (Corporate Debtor) and places the Insolvency Professional (IP) at the helm of the organizational and fiscal management of the company as a going concern.
This is in line with the corporate resolution insolvency process enumerated in IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 (“CIRP Regulations”) which suspends the powers of the Board of Directors, once the IRPs are appointed by National Company Law Tribunal (“NCLT”). Thus, with the suspension of the Board of Directors, the officers and managers of the corporate debtor are required to report to the IRP. This also means that it is the duty of the IRP to protect and preserve the corporate debtor’s properties and manage the operations of the corporate debtor as a going concern.
If a plea for insolvency is submitted to the NCLT by financial or operational creditors or the corporate debtor itself, and is admitted by the NCLT, then CIRP is initiated. There will be an Interim Resolution Professional (“IRP”) appointed with the approval of NCLT. The CoC will later vote and decide on who the IP will be (The IRP can be selected to be the IP by the CoC.).
Various provisions of the Companies Act, 2013 and Securities, and Exchange Board of India (“SEBI”) Regulations have imposed duty on the director to exercise due care and skill and to act in the best interests of the company while entering into business transactions. In this regard, reference may be drawn to the landmark decision of the Delaware Supreme Court in Smith v. Van Gorkom. The Court, in this case, held the board of directors to be grossly negligent and personally liable in approving a cash-out merger proposal that assured shareholders a premium of 39-62 percent (depending upon the method of calculation) over the market price without exercising reasonable care.
Further, the Court opined that in cases where the directors have failed to act in a presumably reasonable manner, they would enjoy no protection and can be held personally liable. Hence, conducting due diligence is important in M&A transactions.Therefore, in order to maintain the integrity of the entire process, it is imperative that confidential information pertaining to the corporate debtor which can be accessed by any potential Resolution Applicant including competitors is kept strictly confidential.
The IBC recognises the importance of maintaining the confidentiality and accordingly requires all Resolution Applicants accessing information about the corporate debtor to comply with provisions of law for the time being in force relating to confidentiality and insider trading, protect any intellectual property of the corporate debtor it may have access to and not to share relevant information with third parties unless the above is complied with. Some have described distressed M&A as an art.
It requires a special skill set and a certain level of risk appetite. As the IBC is still at a relatively nascent stage with several ambiguities and uncertainties, one has to be careful in assessing the potential risks and liabilities which may arise in the future, and also while drafting a resolution plan. However, distressed M&As have their own benefits. Potentially, an acquirer may get an asset at a lower valuation than in ordinary circumstances. We are at the beginning of distressed M&A deals under IBC and such deals are expected to only increase as the IBC regime matures.
With an increasing contribution of distressed M&A to the overall M&A growth, it is important that strategies are set in place which will increase the chances for the success of the transaction. While there are challenges, one will be able to overcome these by having the right expert who possesses overall knowledge about the industry of the target and by laying effective planning and strategy in order to ensure the successful closure of the transaction.
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